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Reconciling VAR-based and Narrative Measures of the Tax-Multiplier

  • Carlo A. Favero
  • Francesco Giavazzi

The currently available empirical evidence shows remarkable differences between various estimates of the effects on U.S output of an exogenous shift in Federal tax liabilities. Shocks identified via the narrative method, imply a multiplier of about three over . an horizon of three years. Tax shocks identified in fiscal VAR models deliver a much smaller multipier of about one. Is this heterogeneity real, or is it simply the result of different approaches to the identification of exogenous shifts in taxes? Or of different specifications of the empirical model used to estimate the tax multiplier? In this paper we reconcile this apparently contradictory evidence by showing that the large multiplier obtained via the narrative identification methods are generated by the choice of a limited information approach in their estimation and not by the different nature of the shocks. Using the shocks identified by a Narrative methods in a multivariate dynamic model delivers estimates of the tax multiplier very much in line with those obtained in the traditional fiscal VAR approach.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 361.

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Date of creation: 2010
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Handle: RePEc:igi:igierp:361
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  1. Glenn D. Rudebusch, 1996. "Do measures of monetary policy in a VAR make sense?," Working Papers in Applied Economic Theory 96-05, Federal Reserve Bank of San Francisco.
  2. Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2006. "Assessing Structural VARs," NBER Working Papers 12353, National Bureau of Economic Research, Inc.
    • Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2007. "Assessing Structural VARs," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 1-106 National Bureau of Economic Research, Inc.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2004. "A Critique of Structural VARs Using Real Business Cycle Theory," Levine's Bibliography 122247000000000518, UCLA Department of Economics.
  4. Bagliano, Fabio C. & Favero, Carlo A., 1999. "Information from financial markets and VAR measures of monetary policy," European Economic Review, Elsevier, vol. 43(4-6), pages 825-837, April.
  5. Eric M. Leeper & Todd B. Walker & Shu-Chun Susan Yang, 2008. "Fiscal Foresight: Analytics and Econometrics," Caepr Working Papers 2008-013, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  6. Burnside, Craig & Eichenbaum, Martin & Fisher, Jonas D. M., 2004. "Fiscal shocks and their consequences," Journal of Economic Theory, Elsevier, vol. 115(1), pages 89-117, March.
  7. Mertens, Karel & Ravn, Morten O, 2008. "The Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks: Theory and Empirical Evidence," CEPR Discussion Papers 6673, C.E.P.R. Discussion Papers.
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